Stephen Message: my 'lonely' bank experience

Since taking over Legal & General Investment Management’s UK Equity Income fund, Stephen Message has been busy restructuring the £276 million mandate.

Most significantly he started paring back some of the largest positions he inherited, in Royal Dutch Shell and HSBC – at one point each made up around 7-8% of the fund.

‘I typically don’t hold more than 5% in any one holding,’ Message explained. ‘I still like those companies, but I reduced those weightings and bought companies like the Phoenix Group, Direct Line.

‘That’s an opportunity to diversify the fund’s yield. I’m still trying to get a portfolio that pays out above average income relative to the market. The UK market yield is about 3.6%, the fund today yields around 4.2-4.3%.’

Underpinning much of his strategy in restructuring the portfolio is the changing tides of monetary policy. With the Fed increasingly hawkish and the Bank of England’s most recent inflation report stoking expectation that it will follow November’s first rate hike in a decade sooner rather than later, he said the direction of travel ‘has turned a corner’.

‘Monetary policy has been incredibly accommodative. The direction is starting to change and, in that environment, a number of companies that have performed well in falling bond yields, that display bond-like characteristics, namely in the consumer goods space, that have enjoyed fantastic rerating, suggest to me ratings might come under pressure.’

‘If you think of the environment when interest rates start to rise, that will be supportive to bank earnings as well. I think about the broader stock market, it still feels reasonably lonely having meaningful exposure to banks. It is going to take a while.

‘Sitting here a year ago, the general view around the prospect of interest rate rises in the UK would have been negligible. Going back to November, the general consensus was that the rate rise there was “one and done”. The process of normalisation is going to take some time but it is coming through, so I’m happy to hold bank shares,’ he explained.

In addition, he believes that within the UK, ‘corporate animal spirits’ are starting to rise, and people starting to look forward instead of the rearview mirror.

‘It’s taken a long time but some of the big macro trends supported, the implications for equity market leadership are starting to change. That’s what’s driving a lot of my thoughts in the portfolio.’

Domestic focus

Since taking over the fund in October 2017, Message has focused on three things: diversifying the income stream, increasing the active share and introducing a value bias.

‘I’m very aware that value relative to growth has endured a tough time. Value has generally struggled since the financial crisis but from a contrarian instinct, they’re the areas I’m finding interesting.’

As a result of the Brexit process, he says a number of companies operating domestically have found their valuations under pressure. This has thrown up interesting opportunities resulting in him taking a position in retailers with strong online franchises, such as Next.

He has also bought Dixons Carphone. ‘[This] clearly had a pretty tough time recently but actually the core electricals business is performing okay. There has been weakness around [the] mobile part: the company has announced they are looking at ways to improve that business. I’m still happy to hold it at the moment. Given my broader macro view where I want to be positioned it fits that theme as well.’

He has also positioned the portfolio to be overweight in resources, particularly mining companies.

‘This is taking a broader view on the mining and commodity cycle. A couple of years ago the market was oversupplied, ultimately leading to dividend cuts. But looking forward, the mindset within the industry is starting to change. Levels of capital investment have been lower, much more disciplined and commodity prices are starting to recover so prospects for dividend growth is more attractive.’

He added that he is monitoring the risk of potential further weakness in China. Another risk he highlighted is the potential for a Labour government, which has meant that he is avoiding utilities.

‘I’m not certain the markets are focused enough on the potential for a Labour government. If the markets were to get more worried about a change in politics within the UK, areas that would likely feel pressure are those they have publicly stated they’ll look into: utilities, water businesses, road and rail, would likely feel pressure.’

In his concentrated portfolio of 45 stocks, they are the main underweights, he said.

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